Financial Conduct Authority
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FSA publishes its Internal Audit Report on: review of the extent of awareness within the FSA of inappropriate LIBOR submissions

The Financial Services Authority (FSA) has published its Internal Audit Report (the Report) on the London Interbank Offered Rate (LIBOR).

The FSA has recently taken enforcement action against Barclays Bank plc (Barclays), UBS AG (UBS) and Royal Bank of Scotland plc (RBS) for failures in respect of LIBOR submissions.  Following the announcement of the Barclays’ fine, Barclays disclosed to the Treasury Committee 13 instances of communication between Barclays and the FSA which raised the question of whether the authorities ought to have been aware that firms might be making inappropriate LIBOR submissions in order to avoid negative media comment (lowballing).

The chairman of the FSA, Adair Turner, therefore asked the FSA’s Internal Audit to identify any other such communications from any firm or from media reports or other information sources which might have provided relevant information, to make a judgement on the appropriateness of the FSA’s response at the time, and to recommend, if necessary, changes to future approaches and working arrangements.

The Internal Audit Report covered the period January 2007 to May 2009.  Internal Audit searched 17 million records, reviewed 97,000 documents in detail, and interviewed 20 FSA employees or ex-employees. 

The Report identifies important areas where the FSA should have performed better, and makes valuable recommendations for the future, but does not suggest major regulatory failure  on the scale identified in the Northern Rock (March 2008) or RBS (December 2011)  reports.

The Report identifies that the FSA, at all levels of management, was aware of severe dislocation in the LIBOR market in the period from summer 2007 to early 2009.  However, this dislocation reflected market conditions, and would have occurred even if lowballing had not occurred.

The Report identifies however a number of instances where information available provided some indication that lowballing might be occurring.  Of the 97,000 documents reviewed in detail, 26 are judged as providing a direct reference to lowballing or a reference that could, in Internal Audit’s judgement, have been interpreted as such.  The two clearest indications relating to a specific firm were the telephone calls from Barclays in March and April 2008, which were included in the FSA’s Final Notice on Barclays published on 27 June 2012.

On the basis of this analysis, the Report concludes that

  • The FSA’s focus on dealing with the financial crisis, together with the fact that contributing to and administering LIBOR were not ‘regulated activities’, led to the FSA being too narrowly focused in its handling of LIBOR related information.
  • Taking the information cumulatively, the likelihood that lowballing was occurring should have been considered.
  • The information received should have been better managed.

FSA chairman Adair Turner commented: 

“As the financial crisis developed in 2007 to 2008, the FSA’s bank supervisors were primarily focused on ensuring they understood the prudential implications of severe market dislocation. And the FSA had no formal regulatory responsibility for the LIBOR submission process.  As a result, the FSA did not respond rapidly to clues that lowballing might be occurring.  There are important lessons to be learnt about effective handling of information: these are identified in the Report and will be taken forward by both the FCA and PRA management. A particularly important lesson is the need to have staff focused on conduct issues even when the world rightly assumes that the biggest immediate concerns are prudential; and vice versa. The new ‘twin peaks’ model of regulation will deliver this.

“The Report also reveals that while some information was available relating to lowballing, there is, for the period covered, no evidence of any information, direct or indirect, available to the FSA which indicated that traders were manipulating  LIBOR for profit.   All of the authorities, both UK and US and elsewhere only discovered trader manipulation as a by-product of enquiries launched into potential lowballing.  This raises important issues about the regulatory tools best suited to identifying such market manipulation.  More intense supervision may not be the most appropriate lever. Better whistleblowing procedures, greater accountability of top management, and more intense requirements for self-reporting of suspicious activity may turn out to be more effective tools.”

LIBOR submission and administration will be regulated activities from 1 April 2013 and the FSA, together with the new LIBOR administrator, will agree appropriate market monitoring and oversight for LIBOR.

The Report draws out six lessons to be learned for the future regulatory authorities, the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA), to consider:

Activities outside the regulatory perimeter and their implications

  • The Report questioned whether there might be other significant non-regulated activities, where wrongdoing by regulated firms in relation to those activities could breach the FCA and PRA Principles for Businesses, pose a threat to the safety and soundness of those firms, or potentially cause significant consumer or market detriment.  
  • The Report recommends that FCA and PRA senior management consider how such activities will be identified and assessed by the new regulatory authorities’ risk and governance frameworks, so that risk-based prioritisation decisions can be made in relation to them.

Roles and responsibilities      

  • The Report recommends that the FCA satisfies itself that there is a clear division of responsibilities relating to LIBOR between the authorities (in the new regulatory framework), including for receiving and sharing LIBOR-related information and for acting on that information where necessary. 
  • It recommends that the FCA (in consultation with the PRA if necessary) establish clear internal roles and responsibilities relating to LIBOR.

Culture of the regulatory authorities 

  •  The Report recommends that FCA and PRA senior management embed appropriately the lessons from the Report in the cultures of the regulatory authorities. 

How the regulatory authorities use and record information and intelligence 

  • The Report recommends that as an important element in developing the desired culture of the FCA and PRA, alertness to the need to share intelligence appropriately should be reinforced as a principle for all staff behaviour. 
  • It also recommends that the FCA and PRA senior management should clarify responsibilities in relation to the use of information from external sources including analysts’ reports, media articles and market data.

Circulating and escalating information                

  • The Report recommends that the FCA and PRA establish effective working arrangements for the circulation and sharing of information, including to whom information should be circulated and the action required of the recipient.
  • It also recommends that the FCA and PRA establish effective working arrangements for the escalation of information to senior management.

Record keeping           

  • The Report recommends that in developing their records management policies, the FCA and PRA include success measures and key performance indicators that take into account the lessons raised in the review and the review’s inherent data limitations. 

The lessons to be learned in relation to lowballing include how the FSA might have better interpreted or responded to the information flows which were available at the time.  In relation to derivatives traders however, the Report found no evidence to suggest that there were any communications, or, pieces of information which might have alerted FSA staff to this issue. 

The question raised by the Report is whether it would have been feasible to have a supervisory approach in which facts relevant to the derivatives trader issues would have come to light.  It is not clear that it would have been, without an impractically intensive supervisory approach (e.g. regulators cannot have supervisors in every dealing room).  This illustrates that some potential problems cannot be spotted by direct supervision in advance but have to be:

  1. policed by firms themselves on a day to day basis;
  2. with effective processes for the supervisory review of firm systems and controls;
  3. Subject to whistleblowing and other procedures to bring problems to light;
  4. Subject to exemplary post facto penalties when offences do occur.

Notes for editors

  1. The Internal Audit Review and Management Response can be found on the FSA website.
  2. The enforcement action taken against Barclays, UBS and RBS can be found on the FSA website.
  3. ‘LIBOR Dislocation’ is defined in the report as the dislocation between LIBOR and other indicators.
  4. The action taken against firms in relation to LIBOR comprised two distinct elements:
    • Lowballing for reputational reasons – firms reduced their LIBOR submissions during the financial crisis in an attempt to avoid negative media comment on their cost of borrowing; and
    • Manipulation of rates to increase position-taking profits – traders, whose bonuses depended on complex deals linked to LIBOR, had an interest in pushing LIBOR up or down depending on the deal.  Webs of traders within and across banks systematically attempted to manipulate LIBOR to benefit themselves and one another.
  1. The Internal Audit report is the third public report in which the FSA has evaluated its effectiveness in the period up to and including the financial crisis, following the Internal Audit Report into the failure of Northern Rock (March 2008) and the Board Report into the Failure of RBS (December 2011).  The reports into Northern Rock and RBS identified clear examples of regulatory failure - both in the international capital framework and in the FSA’s own approach to supervision - and made recommendations that helped transform the performance of the FSA.
  2. In total, the Report found 74 communications, of which 26 included a direct reference to lowballing.  The majority of these were in the period between April 2008 and June 2008.   Although the remainder of the communications did not have a direct reference to lowballing, they could have provided such an indicator, particularly when considered in aggregate. 
  3. Following the publication of the enforcement action against Barclays in June 2012, the Chancellor of the Exchequer asked Martin Wheatley, CEO designate of the FCA, to consider whether the revelations surrounding LIBOR required a wider policy response. The Wheatley Review, published in September 2012, made clear that the process for setting and policing LIBOR was fundamentally flawed.  The system had in-built conflicts of interest which were inadequately controlled by both the contributing banks and the British Bankers’ Association (BBA), the body responsible for overseeing LIBOR process.  The system also lacked external accountability, as the FSA did not regulate LIBOR and individual employees involved in the LIBOR process did not have to be approved by the FSA.
  4. The Wheatley Review made ten recommendations for the Government, the BBA, the banks and the regulatory authorities, both in the UK and internationally  The Government accepted these recommendations in full and introduced legislation, in the Financial Services Act, to:
    • Bring benchmark-related activities within the scope of statutory regulation, including the submission and administration of LIBOR;
    • Create a new criminal offence for misleading statements in relation to benchmarks such as LIBOR, as well as amending the language of existing offences; and
    • Enable the FCA to create a specific power to make rules requiring authorised persons to contribute to a specified benchmark (e.g. LIBOR). Such rules may refer to the Codes issued in relation to the administration of the benchmark.
  1. The FSA regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000: maintaining market confidence; securing the appropriate degree of protection for consumers; fighting financial crime; and contributing to the protection and enhancement of the stability of the UK financial system.
  2.  The FSA will be replaced by the Financial Conduct Authority and Prudential Regulation Authority in 2013 as required by the Financial Services Act 2012.


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